A loan against mutual funds is a type of secured loan where the borrower pledges units of mutual fund schemes (equity or debt) as collateral to the lender (a bank or NBFC). Based on the Net Asset Value (NAV) of the mutual fund units, the lender sanctions a loan amount, typically a certain percentage of the fund’s current value.
Key Characteristics:
- The investor continues to hold the mutual fund units.
- Ownership remains with the investor, but the lien is marked in favor of the lender.
- Loans are usually offered as overdraft or term loan.
- Interest is charged only on the amount drawn from the sanctioned limit.
How Does It Work? Step-by-Step Process
1. Loan Application
You approach a lender (bank or NBFC) that provides loans against mutual funds. The application process is typically digital and faster than traditional loans.
2. Pledging of Units
You choose the mutual fund schemes and number of units to pledge. These are pledged electronically via platforms like CAMS or KFintech.
3. Valuation and Margin
The lender assesses the NAV of the pledged units and applies a margin to determine the loan eligibility:
- For equity mutual funds: Up to 50% of the NAV
- For debt mutual funds: 70%–80% of the NAV
4. Lien Marking
The units are marked with a lien in favor of the lender. You cannot sell or redeem these units until the loan is cleared.
5. Loan Disbursal
Once the lien is registered, the loan is disbursed into your bank account or overdraft facility is activated.
Pledging Mutual Funds: What Does It Mean?
Pledging mutual funds means temporarily giving the lender legal claim over your investments. You retain ownership, but cannot access or redeem the units while the loan is active. Once the loan is fully repaid, the lien is removed and the units become free again.
This is a beneficial arrangement for those who:
- Don’t want to sell investments during a market downturn
- Need funds urgently without a good credit history
- Want to continue enjoying potential capital gains/dividends during the loan period (if allowed by the scheme)
Loan Against Mutual Funds vs. Personal Loan
| Feature | Loan Against Mutual Funds | Personal Loan |
|---|---|---|
| Security | Secured by mutual fund units | Unsecured |
| Processing Time | Fast (can be within hours) | Usually takes 2–3 days |
| Eligibility | Based on value of holdings | Based on credit score, income |
| Interest Rate | 9% to 12% approx. | 11% to 24% approx. |
| Credit Score Dependence | Not critical | Highly dependent |
| Loan Tenure | 1–3 years or more | 1–5 years |
| Loan-to-Value Ratio | 50%–80% depending on type | Not applicable |
| Documentation | Minimal, often online | More documentation required |
Conclusion:
For those who already hold sizable mutual fund investments, taking a loan against them is cheaper and faster than applying for a personal loan, especially if the borrower has a weak credit profile.
When Is It a Good Option?
Loans against mutual funds can be ideal under the following circumstances:
- You need quick liquidity without disturbing your investments.
- You don’t have a strong CIBIL score to qualify for a personal loan.
- You anticipate being able to repay the loan quickly.
- You are confident that your fund’s NAV will not fluctuate significantly.
According to Mr. Dhiraj Nagal, loans against mutual funds are a preferred credit facility for first-time borrowers or those with little or no credit history.
Limitations and Restrictions
While this credit facility is attractive, there are certain conditions and limitations:
- Not all mutual fund schemes qualify:
- New Fund Offers (NFOs)
- Very low AUM schemes
- Sector/thematic funds may not always be accepted
- Loan eligibility varies by fund type:
- Higher margin for debt funds
- Lower eligibility for volatile equity funds
- No redemption allowed during the loan:
- Investors lose access to pledged units
- Cannot switch, redeem, or exit until the lien is removed
Banks and NBFCs Offering These Loans
Public & Private Sector Banks:
- HDFC Bank
- State Bank of India (SBI)
- ICICI Bank
- Axis Bank
- Bank of Baroda
NBFCs:
- Tata Capital
- Bajaj Finserv
- Volt Money
- Aditya Birla Finance
Interest Rates:
- Vary between 9% to 12% depending on the institution and type of fund
- May include processing fees ranging from ₹500 to ₹2,000
- Prepayment charges are generally low or NIL
Risks Involved in Loan Against Mutual Funds
Despite being a convenient option, loans against mutual funds come with inherent risks and considerations.
1. Market Risk / Margin Shortfall
Mutual fund NAVs fluctuate with market movements. If the value of pledged units drops significantly, you may face a margin call.
Example:
- NAV value at time of loan: ₹1,00,000
- Loan disbursed: ₹50,000 (50%)
- NAV drops to ₹95,000
- Margin shortfall: ₹2,500
- You need to pay this shortfall within 6 days
Consequences of Default:
- If you fail to pay the shortfall in time, the lender may sell part of your pledged funds
- This could be twice the margin gap to cover future risks
- Units sold cannot be recovered
2. Interest Costs
Though lower than personal loans, interest is still applicable and compounds if unpaid. Annual interest must be paid on the utilized amount.
3. Locked-In Investments
- Pledged funds cannot be withdrawn or redeemed.
- This limits liquidity and flexibility.
4. Tax Implications
- Selling pledged units by the lender (in default) could trigger capital gains tax liability in your name.
5. Limited Loan Amount
- If your investment value is low, the available loan amount may not be sufficient for larger expenses.
Expert Opinions
Dhiraj Nagal – Financial Advisor:
“Margin shortfalls are a critical risk. Borrowers often ignore this aspect. If NAV drops and you fail to top up the shortfall, you lose more than expected.”
Nirav Karkera – Fisdom Securities:
“Borrowers must understand that while this is a quick loan route, they are essentially freezing their investments. The cost includes not just interest, but also processing charges and opportunity loss.”
Things to Keep in Mind Before You Borrow
Evaluate Your Need
Only borrow if absolutely necessary. Avoid using this option for discretionary spending.
Understand Terms Clearly
Check:
- Interest rate
- Loan-to-value ratio
- Tenure
- Margin call policy
- Processing fees
Keep an Eye on NAV
Regularly monitor the performance of your pledged funds. Be prepared to repay part of the loan if a margin call occurs.
Have a Repayment Plan
Even if no EMIs are involved initially, you must have a strategy to repay principal + interest within the tenure.
Diversify Collateral
If possible, pledge both debt and equity funds to balance risk and raise a higher loan amount.
Conclusion
A loan against mutual funds is a powerful financial tool for those seeking instant liquidity without disturbing their long-term investments. It is faster and more affordable than personal loans and ideal for emergency situations. However, the borrower must tread carefully, considering the risks of market fluctuations, margin calls, and investment lock-in. Always remember mutual funds are subject to market risk, and pledging them amplifies that risk with the added burden of credit repayment. If used wisely and for the right reasons, it can be a low-cost, flexible financing option that helps you meet urgent needs without derailing your investment journey.
